Some random thoughts on game theory, behavioural economics, and human behaviour

Tuesday, 5 January 2016

What is (not) wrong with high rail fares in the UK?

On Saturday rail fares in the UK rose by an average of 1.1%. This is the latest instalment in a long running trend of fair increases. Indeed, average fares have risen by around 40% over the last decade. As usual passengers were queuing up to say how disgraceful it all is. This year the opposition leader Jeremy Corbyn joined the fray with his standard call for a renationalisation of the railways. But what is the problem with high rail fares?

The main reason I ask this question is one of revealed preference. At the same time as complaining about high fares, most passengers also complain about having to stand on over-crowded trains. Indeed, use of the railway has soared, with over 70% more journeys now than in 2002. Moreover, I don't think that anyone would seriously dispute that the UK rail network has just about reached the limit of its capacity in terms of the number of trains operating.

If a price rise is accompanied by a reduction in demand then we can start to think about firms exploiting a monopoly position to extract high profits. But, when a price rise is accompanied by an increase in demand then the only logical conclusion is that there is excess demand. And if supply, in the short term, is fixed by the extent of the railway network then there is a strong argument that prices are not high enough.

Put simply, if passengers continue to use the railways at higher prices then they reveal that prices are not too high. The response to this would no doubt be that passengers have no choice to use the railway. But that is not true. Passengers can change where they live, change job, change the time they commute etc. Furthermore, enterprising soles could no doubt come up to alternatives to high rail fares such as companies that allow working at home or have office hours that can exploit off-peak fares. From an economists perspective, passengers choose to pay the high fares.

Another objection to high fares is that it disadvantages the poor. This argument, though, does not stand up to any kind of scrutiny. The main users of the rail network are the relatively well off, not the poor. Also, despite high fares, the rail network is heavily subsidised by the taxpayer. To lower fares would require an inevitable increase in taxpayer subsidy and would, most likely, be a regressive policy that benefits the relatively well off. (A recent article in the Economist touches on these issues.)

If high rail fares are neither inefficient, nor inequitable, what is the problem? Suppose you spend £50 for a ticket on a commuter train and then have to stand up the whole journey. The economics textbook tells you that you reaction is supposed to be: I wish the fare had been £100 because then less people would have turned up and I would have got a seat. The common reaction, however, is presumably something like: when I pay £50 I expect a decent service and standing-up is not good enough. It just seems plain unfair to pay so much for a poor quality product. In a seminal article published in 1986 entitled 'Fairness as a constraint on profit seeking', Daniel Kahneman, Jack Knetsch and Richard Thaler show that people particularly dislike price increases that are due to shifts in demand. The outrage at rail fare increases seems to fit that picture.
So, what could we do? Lowering fares might make people feel less exploited but would only exasperate excess demand. So, this is not the solution. Increasing supply would help but is only a long run possibility. Another option is to push fares higher but put a headline grabbing tax on the rail companies. Then, at least, passengers would not feel exploited. The train operating companies, though, do not make particularly high profits and squeezing these further is unlikely to increase the quality of rail services. Which brings us finally to renationalisation. If this is to lower fares then the taxpayer will have to pay the difference. And as I have argued this benefits the rich at the expense of the poor, which hardly seems desirable. The status-quo, therefore, seems not so bad.